Recession hits "pretty grim" EU states in the east

By Michael Winfrey

6 Min Read

PRAGUE (Reuters) - The Czech Republic's economy shrank for the third quarter in a row and Romania fell back into recession from January to March, as the euro crisis and government austerity hammered domestic demand and squeezed exports across central and eastern Europe.

Flash gross domestic product estimates for the European Union's emerging states also showed Hungary had contracted in annual terms for the first time since the height of the global economic crisis in 2009.

The data in all three countries was worse than forecast by economists in Reuters polls, prompting many to say it could intensify debates in those countries' central banks over whether to cut interest rates despite a need to keep investors interested with high risk premiums.

They also warned that the figures had come before early indications of a decline in manufacturing across the region at the start of the second quarter.

"It's pretty grim. The worst part is that it shows output in large swathes of the region was contracting even before the most recent escalation of the euro crisis," said Neil Shearing, an emerging markets economist at London-based Capital Economics.

"So I expect the second quarter is going to be worse."

SLIDING DEEPER

Romania, the European Union's second poorest economy, slipped back into recession, shrinking 0.1 percent versus the previous quarter due to a devastating cold snap and snow storms that shut down production in January and waning demand for its exports in the euro zone.

The Czechs, whose government has cut spending and hiked taxes to slash its fiscal shortfall to the EU's 3 percent of GDP ceiling this year, suffered a much worse-than-expected drop of 1 percent versus the previous three months.

It was the third straight contraction in what the central bank has forecast could be a five-quarter recession.

Hungary, whose right-of-centre government is trying to launch talks with the European Union and International Monetary Fund for an aid loan backstop, shrank 1.3 percent.

The second time since the middle of last year, following stagnation from October to December, it did not meet the technical definition of recession, which is two consecutive quarters of shrinkage.

But analysts said the fourth quarter could be revised to a multiple-quarter slide and the government's forecast for stagnant growth this year could be threatened.

"Sadly, we have fallen into recession. The second-quarter figure is likely to be bad too," said David Nemeth, an analyst at ING Bank in Budapest.

Bulgaria, also hit by freezing weather and the euro zone slowdown, stagnated from the previous quarter, while its annual growth rate slowed to 0.5 percent.

The only country to buck the trend so far was Slovakia. The euro zone member state grew by a faster-than-expected 0.8 percent versus the previous quarter following the opening of a new production line at the country's Volkswagen plant that is gradually boosting production.

Poland, the region's largest economy and the only country not to fall into recession during the crisis, will release its first quarter GDP on May 31.

AUSTERITY BITES

The data indicated a gathering storm of negative influences was taking a toll on the region.

Although exports were strong at the start of the year - crucial for countries such like Hungary and the Czech Republic, where sales abroad make up 80 percent of output - growth in that sector declined in March.

Manufacturing data from the forward-looking Purchasing Managers' Index (PMI) also slipped below the break even level in those two countries and Poland in April.

In Romania and Bulgaria, where pre-crisis booms were fuelled by a huge inflow of foreign banking capital that boosted domestic consumption, foreign banks have been reducing their exposure, causing declines in lending that has hit growth.

And governments have tried to slash costs, either under an IMF loan program such as in Romania, a threat from the European Commission for exceeding its deficit rules for Hungary, or a belief in the Czech and Slovak governments of the need to slash budget deficits to prevent borrowing costs rising.

That has put consumers on the defensive and hit investment both by governments into infrastructure and businesses into expanding their activities.

It could threaten growth targets in struggling countries, ranging from stagnation in the Czech Republic and Hungary to sub 2 percent expansions in Romania and Bulgaria.

And in turn, it could put pressure on those government's plans to reduce their budget deficits, as lower growth usually translates into lower tax revenues.

"The numbers are very disappointing as the first quarter was always meant to be the strongest quarter of the year," said Nomura emerging economist Peter Attard Montalto. "And particularly with the crisis intensifying in Europe, it probably shows that we need to substantially mark down 2012 GDP forecast for all open economies, like Hungary, Czech, and Romania."

Additional reporting by Jana Mlcochova in Prague and reporters in Bucharest, Budapest, Bratislava and Sofia; Editing by Jeremy Gaunt.